June 25, 2006

Complexity economics and wealth

Economics is in the midst of a revolution – its biggest in over a century. There are new insights into the workings of the economy. “Complexity Economics,” as Beinhocker of McKinsey calls the new paradigm, views the economy as a highly dynamic, constantly evolving system, more akin to the brain, the Internet, or an ecosystem than to the static, equilibrium picture presented by traditional theory.

One of his main points is that wealth is the result of evolution. If this is correct, then the job of strategists, policy makers and managers is to make countries and companies and people better able to adapt to those evolutionary forces.

Some insights that complexity economics has for the economy follow * Historically, the right has viewed government as the problem and the left has viewed it as the solution—from an evolutionary perspective, neither is correct. * Governments play a vital role in enabling economic evolution, and therefore wealth creation, to occur—weak government institutions can stop economic evolution in its tracks, as seen in many developing countries. * Governments provide a framework for economic evolution to operate in, and can also play a legitimate role in shaping the “fitness function” of the evolutionary environment toward social ends—for example in environmental policy—but should avoid selecting winners and losers in the competition between business designs.

* Evolutionary theorists have a saying that “evolution is cleverer than you are”—rather than trying to out-guess and out-predict economic evolution, business leaders should seek to harness evolution’s power to innovate. * Managers should abandon strategic planning processes that rely on predicting the future and instead “create portfolios of strategic experiments” that are robust against a range of possible outcomes. * Creating such portfolios requires companies to develop processes for encouraging strategic variety within their businesses, using market feedback to select promising experiments, and then rapidly channeling resources to scale up experiments that succeed.

* In constantly changing markets, competitive advantage is short-lived and most companies have a difficult time refreshing their sources of advantage —research shows that just five percent of companies are able to sustain superior performance for ten years or more. * Significant barriers exist within firms that prevent the evolutionary processes of variation, selection, and amplification from working as well inside companies as they do outside in the marketplace—this means that companies are less adaptive than the markets they compete in. * Managers need to change company structures, processes, and in particular culture, to break these barriers down and get the wheels of evolution spinning inside their companies as effectively as they spin in the marketplace.